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Tax policy 'hitting' entrepreneurs

Mahesh Sharma

Start-ups want the ATO to simplify ESOP rules so they can reward emloyees and foster innovation onshore. Photo: Michel OSullivan

A taxation policy designed to close a loophole is penalising technology start-up businesses that want to offer stock options to employees to compete on the world stage.

Australian software developer Atlassian bore major expenses to offer stock options to about 500 employees, with the bet poised to pay off later this year when the company is expected to list on the US tech stock index NASDAQ.

Australian e-commerce software maker Bigcommerce today announced it has issued stock to its employees at a great cost to the company.

"From day one, it was obvious we needed an ESOP – timing was the only question," Bigcommerce founders Mitchell Harper and Eddie Machaalani said in an opinion piece running in IT Pro today.

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"This July, every one of our team members (all 170 of them) in the US and Australia became a stock owner of Bigcommerce. It was one of our proudest moments as founders."

Other small companies and employees have not been so lucky. Niki Scevak, founder of business accelerator Starmate said there are unnecessary hurdles for start-ups wanting to offer Employee Share Option Plans (ESOPs).

"People should pay tax when they get the money from the sale. In Australia you pay tax upfront on a sketchy, best-effort valuation of the equity. It's about paying tax when you get money, rather than paying tax before you get money," Scevak said.

ESOP offers discounted shares to employees in the hope of a financial benefit when the company's share price rises. The instrument incentivises hard work and long tenure.

For cash-strapped, unlisted companies stock options complement wages,secure highly-skilled workers and allow them to compete with larger salaries offered by corporates. They are a cornerstone of the Silicon Valley entrepreneurial culture, having underpinned the growth of Google, Apple, Microsoft, and Facebook.

In the US the tax is paid when the option vests. In Australia, companies must pay tax when the stock option is issued or acquired by the employee.

This is prohibitive for those generating small revenues, according to Atlassian vice president of human resources Joris Luijke, whose company offer options to every employee including the receptionist.

"As an example, for a receptionist, to [get] $20,000 worth of options, you may have to put on the table $4,000," according to Luijke.

Atlassian afforded the expense but Luijke said many others can't.

"To do that across the organisation will cost you too much. That's why so many [companies] don't do it. It's a really big decision for us because we want people to feel that as Atlassian grows, they grow as well, and feel the direct result."

The offending piece of legislation is Division 83A of the Income Tax Assessment Act 1997, according to Remuneration Strategies Group director Gary Fitton. Div83A stipulates employees be taxed when the options are issued.

The tax can be deferred until vesting, Fitton said, but very limited conditions imposed by the ATO and Treasury prevent start-ups from qualifying for exemptions.

"Div83A is messy, restrictive, and a disincentive to offering stock options," he said.

The bureaucrats have imposed their idea of how an option should work, not what's best for a start-up or company.

Div83A was introduced in 2009 to curb exploitation of the system, but according to Andreyev Doman partner Andrew Andreyev, the law has regressed so far there's no legitimate stock options regime for entrepreneurs.

"There were a lot of employee-type benefit arrangements that happened in early 90s and 2000s that were clearly artificial structures exploiting the system. They were turning what would be normal remuneration into an exempt benefit or capital gain, which was clearly contrary to the whole intention of the scheme.

"But [the government] has gone too far . There's no legitimate regime for entrepreneurial businesses to offer equity in a high-growth business in Australia. That puts us at a competitive disadvantage."

99designs CEO Patrick Llewellyn said the law was overly complex.

"It would be terrific to see a simplification of the tax treatment of ESOPs in Australia so that more start-ups could cost-effectively use them."

10 comments so far

just go see your tax adviser. I am sure a good mid-tier firm would know how to structure these so that you get tax deferral.

Commenter

M.Stephens

Location

Sydney

Date and time

August 28, 2012, 11:49AM

If you think the ATO position on ESOP is a disincentive to Aussie Start-ups you should look at the ATO treatment of foreign currency positions, especially during times of wild fluctuations in the value of the Aussie Dollar. It is beyond stupid...

These ATO guys simply dont understand that that operational costs an Aussie high tech start-up faces, are likely to be dominated by $USD not $Aussie. It makes perfect sense for all cash to be held in USD because dominate profits losses and costs are USD. Instead we have exchange rate gains and losses creating absurdly complex accounts and potential Tax costs for a development level organization. As I said beyond stupidity....

Commenter

China-Bob

Date and time

August 28, 2012, 12:44PM

I agree, this is a very bad deal for Australian companies. But, if I recall correctly this was only changed recently by the Treasurer Wayne Swan. I guess Mr. Swan doesn't understand Australia is competing in an international arena.

Commenter

dis

Location

Sydney

Date and time

August 28, 2012, 5:22PM

If we want to see a huge surge in innovation, new companies and recycling generations of investing entrepreneurs to fuel it, a better ESOP would really help.

Mick, Pollenizer

Commenter

Mick Liubinskas

Location

Sydney

Date and time

August 28, 2012, 11:23PM

The ATO does not care about anything beyond taking in revenue that the government considers theirs. It is draconian, it is a function of the Grand Parliament. Always remember the Americans only ever caught Al Capone for tax matters! The ATO remains jealous.

Commenter

ArghONaught

Date and time

August 29, 2012, 7:33AM

Neither the ATO nor ASIC make any allowances for startups in Australia. The culture is more one of policing and penalising. In the eighties and nineties we were losing potentialy profitable startup companies to the US. Post 2000 Asia has been added to the US and Europe as competitors. The loss of a startup company to another country means an increase in global competition for capital and human resources in addition to the loss of tax revenue for the government. Australian seed and venture capital is risk averse with ridiculously unrealistic expectations. The startup culture in Australia has to change and the leadership for this has to come from the ATO and ASIC. Contra rulings like the Div 83A ruling in the article above, merely reinforce the ATO culture of police and penalise. This culture is destructive to Australia's future as a 'smart' advanced economy in an escalatingly competitive global economy. The ATO and ASIC have to come to the understanding that they are no longer the only ones making the rules!

Commenter

DontStartupInAus

Date and time

August 29, 2012, 7:35AM

I didnt realise we have a new (backdated) Income Tax Assessment Act 1987????? I am noticing more and more mistakes like these in smh online.

Commenter

noidea

Location

sydney

Date and time

August 29, 2012, 9:12AM

fixed.

Commenter

Ed

Date and time

August 29, 2012, 10:43AM

Fix might be as simple as creation of trust (company) where Australian employees options are held pending or released upon vesting/IPO/sale. Trust would be owned by the company. Company/Employee could then decide when the taxable event would occur not the ATO.

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